September 28, 2010

The Bank of England’s Adam Posen Joins the Reanimation Caucus

We have moved beyond mere need for more stimulus to get the recovery on track. The recovery is dead We are now at the stage where what is needed is more: the reanimation of dead tissue.

David Wessel listens to Adam Posen as he joins the reanimation caucus and says: "GIVE THE ECONOMY... LIFE!!!":

Bank of England’s Posen: Central Banks Should Do More — A Lot More: Adam Posen, an American who sits on the Bank of England’s Monetary Policy Committee, is no on-the-one-hand-this/on-the-other-hand-that economist. In a speech at the Chamber of Commerce in Hull today, Posen made the case that the world’s central banks — not only in the U.K. — urgently need to pursue more aggressive bond-buying to rescue the world economy from stagnation that clouds the future as well as the present.

Along the way, he adds a few new metaphors to the debate over central banking: “Fear of looking ineffective should not be a deterrent to doing the right thing," he said:

When facing a worsening situation, you work with the tools you have, whether you’re a central bank in the aftermath of a financial crisis, or someone stranded on the road with a car problem when night is falling. And you try to get help. In every major country, actual output has fallen so much versus where trend growth would have put us, and trend growth has not been above potential for long enough as yet, that there remains a significant gap between what the economy could be producing at full employment and it currently produces. Thus, policymakers should not settle for weak growth out of misplaced fear of inflation...

Despite a 3.1% increase in consumer prices over the past 12 months in the U.K., Posen said that “if price stability is at risk over the medium-term, meaning over the two- to three-year time-horizon for the Monetary Policy Committee’s decisions, it is on the downside.”

There are… some very serious risks if we make policy errors by tightening prematurely, or even if we loosen insufficiently. Those risks are not primarily the potential for a double-dip recession or even of temporary measured deflation. While bad, those situations would still be within the range of short-term cyclical developments, and could be weighed against simple inflationary pressures from monetary policy trying to stimulate too much. The risks that I believe we face now are the far more serious ones of sustained low growth turning into a self-fulfilling prophecy, and/or inducing a political reaction that could undermine our long-run stability and prosperity. Inaction by central banks could ratify decisions both by businesses to lastingly shrink the economy’s productive capacity, and by investors to avoid risk and prefer cash. Those tendencies are already present, and insufficient monetary response is likely to worsen them.

Posen, a Harvard Ph.D. economist who maintains a perch at the Peterson Institute for International Economics, a Washington think tank, said the only central bank weapon with sufficient oomph is likely to be more “large scale asset purchases,” or LSAP, another term for “quantitative easing.” Although he suggests the Bank of England buy more gilts, or U.K. government bonds, he expressed interest in purchasing corporate or other private bonds as well.

Posen expressed impatience with central bankers around the world who would rather wait and gauge the impact of the steps they have taken already.

We will only know we will have done enough with QE [quantitative easing] or other monetary stimulus when we have clear indications that our policies are moving the desired variables — market interest rates, wages, output, employment, and inflation expectations — sufficiently and in the right directions on a sustained basis. I do not think that is not enough for a central bank to say, ‘Look, we expanded our balance sheet more than any time in history,’ or ‘we did things we never did before,’ and argue that therefore we must have done a lot, if not too much (not that the Bank of England has done so). In my opinion, that is backwards logic. It would be like saying ‘that fire must be out, because we’ve already pumped more water than for any previous fire we’ve fought,’ or ‘we must have gotten to our destination, because I’ve been driving for hours and we’ve already used a full tank of gas.’

This is a worse fire than any of us have ever seen in our lifetimes, and we are farther from home than we have ever been, and so we cannot judge our progress by how much effort or resources we have already put in,” he continued. “We can only gauge the success of our efforts by our results, and until we achieve those results, there is no danger from our heavy use of the available instruments. This is not a normal situation with finely balanced risks on both sides or with monetary policy able to finely calibrate to an outcome...

Comments

We have moved beyond mere need for more stimulus to get the recovery on track. The recovery is dead We are now at the stage where what is needed is more: the reanimation of dead tissue.

David Wessel listens to Adam Posen as he joins the reanimation caucus and says: "GIVE THE ECONOMY... LIFE!!!":

Bank of England’s Posen: Central Banks Should Do More — A Lot More: Adam Posen, an American who sits on the Bank of England’s Monetary Policy Committee, is no on-the-one-hand-this/on-the-other-hand-that economist. In a speech at the Chamber of Commerce in Hull today, Posen made the case that the world’s central banks — not only in the U.K. — urgently need to pursue more aggressive bond-buying to rescue the world economy from stagnation that clouds the future as well as the present.

Along the way, he adds a few new metaphors to the debate over central banking: “Fear of looking ineffective should not be a deterrent to doing the right thing," he said:

When facing a worsening situation, you work with the tools you have, whether you’re a central bank in the aftermath of a financial crisis, or someone stranded on the road with a car problem when night is falling. And you try to get help. In every major country, actual output has fallen so much versus where trend growth would have put us, and trend growth has not been above potential for long enough as yet, that there remains a significant gap between what the economy could be producing at full employment and it currently produces. Thus, policymakers should not settle for weak growth out of misplaced fear of inflation...

Despite a 3.1% increase in consumer prices over the past 12 months in the U.K., Posen said that “if price stability is at risk over the medium-term, meaning over the two- to three-year time-horizon for the Monetary Policy Committee’s decisions, it is on the downside.”

There are… some very serious risks if we make policy errors by tightening prematurely, or even if we loosen insufficiently. Those risks are not primarily the potential for a double-dip recession or even of temporary measured deflation. While bad, those situations would still be within the range of short-term cyclical developments, and could be weighed against simple inflationary pressures from monetary policy trying to stimulate too much. The risks that I believe we face now are the far more serious ones of sustained low growth turning into a self-fulfilling prophecy, and/or inducing a political reaction that could undermine our long-run stability and prosperity. Inaction by central banks could ratify decisions both by businesses to lastingly shrink the economy’s productive capacity, and by investors to avoid risk and prefer cash. Those tendencies are already present, and insufficient monetary response is likely to worsen them.

Posen, a Harvard Ph.D. economist who maintains a perch at the Peterson Institute for International Economics, a Washington think tank, said the only central bank weapon with sufficient oomph is likely to be more “large scale asset purchases,” or LSAP, another term for “quantitative easing.” Although he suggests the Bank of England buy more gilts, or U.K. government bonds, he expressed interest in purchasing corporate or other private bonds as well.

Posen expressed impatience with central bankers around the world who would rather wait and gauge the impact of the steps they have taken already.

We will only know we will have done enough with QE [quantitative easing] or other monetary stimulus when we have clear indications that our policies are moving the desired variables — market interest rates, wages, output, employment, and inflation expectations — sufficiently and in the right directions on a sustained basis. I do not think that is not enough for a central bank to say, ‘Look, we expanded our balance sheet more than any time in history,’ or ‘we did things we never did before,’ and argue that therefore we must have done a lot, if not too much (not that the Bank of England has done so). In my opinion, that is backwards logic. It would be like saying ‘that fire must be out, because we’ve already pumped more water than for any previous fire we’ve fought,’ or ‘we must have gotten to our destination, because I’ve been driving for hours and we’ve already used a full tank of gas.’

This is a worse fire than any of us have ever seen in our lifetimes, and we are farther from home than we have ever been, and so we cannot judge our progress by how much effort or resources we have already put in,” he continued. “We can only gauge the success of our efforts by our results, and until we achieve those results, there is no danger from our heavy use of the available instruments. This is not a normal situation with finely balanced risks on both sides or with monetary policy able to finely calibrate to an outcome...